These Rich-Yielding Closed-End Funds Trade At A Discount

By Brendan Conway

When it comes to closed-end funds, my colleague Jacqueline Dohertyhad the telling statistic two weeks ago: Sixty-six percent of taxable bond funds and 73% of municipal-bond funds trade above their net asset value, versus about 30% a year ago and about 30% in 2006. What changed?

But not all richly yielding CEFs trade at dangerous premiums. There are some that trade at discounts even though they can fill similar roles as certain dangerously overtrodden CEFs. We spoke with Maury Fertig of registered investment advisor Relative Value Partners on the subject recently. Fertig’s job is to hunt for value in the creaky and inefficient closed-end fund market, focusing on CEFs for the very reason that individual investors often drive this market to kooky outcomes.

“Sometimes in CEFs, it takes years for the market to recognize value,” Fertig says. “It’s a quirky, strange market. [Many investors] don’t understand the nature of the assets and the fact that funds trade to premiums. A lot of people who own them are retail investors just seeking yield.” It leaves opportunities for those who do their homework.

Blackrock Credit Allocation (BTZ): Fertig notes that Blackrock will be merging several other funds into BTZ on Nov. 2. This fund used to focus on equity and preferreds, but it changed to a multi-sector bond fund in 2010, meaning it owns government, corporate, high yield bonds and preferreds, Fertig says. BTZ’s distribution rate is 6.6% and it trades at a 6.6% discount. ”The fund still has not been fully recognized by investors as a bond fund and therefore trades significantly cheaper than the average discount of the median taxable CEF fund today,” Fertig says in a writeup. This fund isn’t using return of capital to pay distributions, he notes. The fund uses an average amount of leverage, around 26% (30% is average).

Alliance Bernstein Income (ACG): A government and corporate-bond fund whose holdings have an average AA rating. It trades at an 8.8% discount and the distribution rate is 5.6%. That’s favorable compared to a weighted average premium on taxable fixed income funds of 2.2% at the moment. ”It doesn’t have an outlandish yield — it’s 5.6%,” Fertig says. “But it’s trading at a nine percent discount. It’s a $2.3 billion fund, so it’s liquid, and historically, if you go back, there are periods of time when this fund has traded very close to NAV. It’s a 3-5% type of discount, in earlier periods,” he adds. No return of capital here, either. This is another average user of leverage, at about 31%.

Eaton Vance Risk Managed Diversified Equity (ETJ) ETJ trades at a nearly 11% discount to deliver a 10%-plus distribution. It uses return of capital to some extent, but not enough to worry Fertig. It buys focuses on both dividend paying equities and uses options for current income and capital appreciation. ETJ’s average discount over recent years is in the low single digits, but it’s gotten slammed after cutting distributions, a fright for investors. The fright appears to be over, though. “Two weeks ago, Eaton Vance came out and publicly said [it] will be maintaining dividends for the rest of the year [and] at the present time [they] anticipate no further cuts,” Fertig says. “It’s very encouraging.”

Eaton Vance Tax Managed Dividend Fund (ETY) is a covered-call fund with some tax advantages. Its distribution is more than 10% and its discount is nearly 11%. Holdings include Apple (AAPL), Exxon (XOM) and Coke (KO). The same comments on dividends by Eaton Vance in the case of ETJ also apply here, Fertig notes. This one’s another user of return of capital, but not enough to turn off Fertig.

Any of these funds make reasonable substitutes for heavily trodden CEFs trading at huge premiums. But if you buy, time it well. In the less-than-rational CEF market, the fall and early winter are usually good times to buy, since investors spend this time selling to meet tax obligations. Expect “exaggerated moves” in the market in the fall as investors sell, Fertig says. But be ready to stand pat early next year. “January is not the time to buy a closed-end fund,” he says, since that’s when big numbers of investors go shopping. “Maybe use it to sell some.”

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There are 3 comments

OCTOBER 17, 2012 1:58 P.M.

chuck wrote:

One comment on ACG: effective duration per Morningstar of 7+ years.

OCTOBER 17, 2012 8:47 P.M.

Jerry wrote:

You continue to show your lack of investing knowledge. You need to find another profession and stop embarrassing yourself.

OCTOBER 18, 2012 2:38 P.M.

CEF Hunter wrote:

ETJ has no NAV upside in a strong market. It's a "risk-managed" fund, meaning it also buys 100% put options as well as selling call options. The best Eaton Vance option-income funds are ETB and ETV which have crushed ETJ but the best value by far is EXG...one of the largest CEFs out there, selling at a -13.2% discount and a 10.7% yield.

About Focus on Funds

As exchange-traded funds and other investing vehicles have ballooned in number, the task of figuring out what works well and what doesn’t has only gotten harder. Barrons.com’s Focus on Funds looks under the hood of ETFs, mutual funds and hedge funds for overlooked values, actionable ideas and the latest pitfalls for fund investors.

Chris Dieterich has covered the U.S. stock market for The Wall Street Journal and Dow Jones Newswires. He is a graduate of Regis University and the Missouri School of Journalism.